Brexit – The Battle For Ideas

The battle for ideas in the Brexit debate comes down to two basic economic approaches. The neo-Keynesian macroeconomists in the permanent establishment, who manage the state as economic planners and regulators are on one side. They are naturally sympathetic with the policies and ideals of their EU counterparts. Against them are those who argue that in economics free markets must have primacy over the state.

It is turning out to be a modern rerun of the socialist calculation debate. In a communist economy, even if one puts to one side the question as to whether the planners’ goals actually align with the public good, planners still require prices to be set in free markets. It is impossible for them to decide the efficient allocation of economic resources when free markets don’t exist, as the collapse of Soviet communism proved. Neo-Keynesians think they have resolved the problem by sanctioning market prices. But they are not free, because they are rigged through government planning, spending and regulation, while the central bank corrupts the unit of account. By advocating socialism-light, they think they can avoid the more obvious consequences of full-bloodied state control, when instead they are only storing up trouble for the future, reflected in mountainous accumulations of debt.

It explains to a large degree the statists’ dependence on statistics, mathematics and general equilibrium assumptions, which are expressed in economic modelling. It is obvious, at least to genuine free-marketeers, that the fallacy lies in not appreciating that an economy is always a dynamic, ever-evolving aggregate of individual actions, which cannot be replicated by a static model. If Brexit is going to work favourably, this central argument has to be addressed and debated, particularly with respect to free trade.

Meanwhile, the battle lines for trade in the Brexit negotiations are being formed. On the one hand, there is the EU as ever playing hard-ball, believing in the dire consequences for Britain of going it alone. And on the other, the Brexiteers, whose minority arguments for freer trade seem to be clarifying and becoming more coherent. Meanwhile, the Remainers in the permanent establishment, who are essentially neo-Keynesian planners uncomfortable with free markets, are quietly undermining Mrs May’s Lancaster House declaration, that Brexit means Brexit.

However, if Brexit is to be delivered, then it must be before the next credit crisis interrupts the process. A crisis of some sort is widely feared in financial and banking circles, as evidenced by stock and bond market commentaries, the research that emanates from bodies such as the Bank for International Settlements, and the desire of the Fed to reduce its balance sheet so it can act as lender of last resort again.

Time is very much of the essence, not only because of the short Brexit deadlines, but because of the evolution of the global credit cycle. It is becoming obvious, to those who have studied it, that on a global scale capital is shifting from financials into non-financials, which is always a late-cycle development. The consequences are rising bond yields (already evident) followed by accelerating rising prices, setting about an increase in interest rates sufficient to disrupt credit demand. As night follows day, a debt crisis always ensues, and given today’s record accumulation of global debt, the upcoming crisis will almost certainly be a major financial and economic disruption.

Based on the observable credit and market dynamics, the time taken to reach this unhappy state is probably no more than a year to eighteen months and is the one event that central banks cannot defer. Consequently, there is a strong possibility that the Brexit process will not be completed by the time of the crisis, particularly if a transition or implementation period is included in any agreement.

All this weighs in favour of an early acceptance of a free trade option as the only sensible objective, instead of a negotiated outcome. For anyone who understands free markets, the best result would be to abandon all negotiations with the EU and state to its negotiators that Britain is going to remove all tariffs. The reasoning behind such a move is fully explained here, and anyone who is not familiar with the economics of trade is recommended to read it.

To summarise, the economic case for free trade is an immediate Brexit, no implementation period, and the removal of all tariffs. Any delay is time wasted. Therefore, it is only politics which we are dealing with.

It’s much ado about not much trade

The actual negotiations could easily run right up to the deadline in March 2019, when Britain is due to leave. If no agreement is forthcoming by that date, both sides might agree to extend negotiations, but that only seems likely if there is a good prospect of an agreement. Otherwise, Britain leaves and falls back on WTO trading rules, or does away with tariffs altogether. This is seen by the EU negotiators as a threat to Britain, believing it is Britain which is running out of time. Therefore, if Britain wants a trade deal, she must make it clear that a no-deal option is attractive to her. And, be it clearly understood, the negotiations only cover a minor part of the UK’s overall economy.

WTO tariffs apply to physical goods, involving only £143bn exported from the UK’s £2,000 billion economy to the EU, and imports from the EU of a larger £235.5bn. Excluding agricultural products of some £5bn (net of spirits), average trade-weighted tariffs on goods imported into the EU from non-member states without a trade agreement is only 2.3%. Therefore, the EU’s external tariffs which will be applied to UK non-agricultural goods exports to the EU involves only 7.5% of the UK’s GDP, and is a tax on EU citizens amounting to roughly £2bn. Is this really worth arguing over, and paying massive divorce fees?

The larger issue is services, and here we must differentiate between services sold to consumers, such as retail investments, and wholesale services, such as capital market operations, commercial lending, legal services, architectural services, etc. The retail services involved are not material, and in any event are easily distributed through locally-incorporated subsidiaries in Dublin and Luxembourg. Wholesale services are generally excluded from trade agreements for practical reasons.

Therefore, if a trade agreement is not forthcoming, the cost to British business as a whole is not as material as the Remainers and lobbying businesses have it, and certainly less than the implied cost of normal currency volatility on cross-border settlements. One should conclude that the absence of a trade agreement costs considerably less than the UK Government paying money to the EU for an implementation period.

The current state of the Brexit debate

It is becoming clear that the Remainers are driven by little more than a desire to prevent change while distrusting free markets. Nick Clegg, who was Deputy Prime Minister in the Conservative/Liberal-Democrats coalition, has recently published a book entitled How to stop Brexit (And make Britain great again). There are no substantive arguments in favour of Remain, not even a neo-Keynesian discourse. Make Britain great again? The book is miss-sold. There is nothing on the subject of the book’s subtitle at all.

Mr Clegg’s unquestioning assumption, which he appears to share with other leading Remainers, is Brexit is just plain wrong. He makes much of the Brexit campaign’s supposed lies about the extent of the rebate when Britain leaves the EU. There was no lie: it merely failed to differentiate between the funds Britain would save, and the money that is spent by the EU in the UK funded by the UK taxpayer. The latter amount is decided by the EU, not the UK, so all the Brexiteers were quoting was a gross figure sent to Brussels, which on Brexit would become available to the Government to save or spend as it sees fit.

Furthermore, there was no mention of “project fear”, the Remain campaign’s concerted effort to frighten voters into voting Remain. But, as we saw only this week, the pro-Remainers in the establishment are at it again. They prepared and leaked another negative report based on the same economic modelling. A reasonable person would have been so embarrassed by the failure of the first attempt at economic propaganda, as to not repeat it. But we are dealing with ingrained beliefs, not reason.

On the evidence, Remainers cannot argue their case effectively. Furthermore, the cost of backtracking on Brexit, which receives too little attention, is now considerable, and almost certainly unpalatable to the electorate. Unless Britain does achieve a proper Brexit, she becomes, taking the words of Jacob Rees-Mogg, a vassal state, having lost considerable political credibility and the ability to influence EU policy as she has done before.

Realistically, bridges have been burnt, even though the panjandrums in Brussels want Britain to change her mind. The Thatcher rebate would certainly be lost, and Brussels is preparing more onerous regulations in the knowledge Britain can no longer obstruct the EU executive’s plans. The Tobin tax on financial transactions can now be introduced, which would kill the City, if Britain remained, more certainly than any threat from Paris and Frankfurt as rival financial centres. A Tobin tax introduced in Euroland after Britain leaves would see Eurozone wholesale financial business migrate to London.

If Britain backtracks or compromises on sovereignty, it will be disastrous for her, and little account has been taken of the new opportunities for the City, operating from outside the EU.

Enter the European Research Group

The ERG, unlike its name might suggest, is the grouping of pro-Brexit backbench Conservative MPs determined to ensure Britain truly leaves the EU. The recent appointment of Jacob Rees-Mogg, as its new high-profile chairman, promises a new dynamism in the battle between the Brexiteers and the Remainers. The ERG has considerable power, being comprised of sixty MPs while Mrs May commands no overall majority.

Further pressure is being applied through the 1922 Committee, which officially represents all backbench Conservative MPs. Amongst them are Remainers and those without well-defined opinions, the latter becoming increasingly alarmed at the lack of a clear government policy. If forty-eight of them formally write to the 1922 Committee expressing no confidence in Mrs May, an election for a new leader (and therefore prime minister) is automatically triggered. It is rumoured that forty such letters have already been received. Between the ERG and the 1922 Committee, the Brexiteers’ ability to pressure the Government into sticking with a firm Brexit policy is increasing.

All this lends support to Mrs May’s original Lancaster House declaration, which is what the ERG is seeking to achieve. In the Commons, opposition to Brexit has been subdued enough to get the required legislation through the House, without major concessions. This is not the case, however, in the Lords, which by sending legislation back to the Commons for reconsideration threatens to delay the whole process at a time of tightening deadlines.

Mrs May’s greatest problems are likely to be in dealing with her own advisors, senior civil servants whose only world is one of bureaucracy, and the Treasury, populated with staunch neo-Keynesians. Bureaucrats resist change, particularly when it involves a whole new paradigm, which is always seen as risky. And the Treasury believes in manipulating the economy to enhance tax income, the antithesis of any free market proposition, with which it has little empathy.

These operators are unhappy at the prospect of past agreements being torn up to be replaced by, in their view, uncertainty. Thus, Oliver Robbins, whose job is to coordinate negotiations with the EU from Downing Street, and Sir Jeremy Heywood, the Cabinet Secretary, are seen by the ERG to be pursuing a policy of fudging the changes required for a true Brexit. And Philip Hammond, the Chancellor, is now being downright obstructive.

However, governments have a duty to represent the electorate, not the permanent establishment, which is there to serve ministers in pursuing government policy. Individual ministers are meant to toe the agreed policy line. Mrs May, in trying to accommodate the Remainers, appears to be in danger of siding with the permanent establishment and the Treasury, against her own stated policy, instead of firmly instructing it to do the Cabinet’s bidding. Doubtless, the ERG will ram this point home.

Keeping the broader picture in sight

It is always difficult for a prime minister at the coal-face of day-to-day problems to retain a broader vision. The ultimate prize for Mrs May would be to go down in history as having laid the foundations for a prosperous Britain. To achieve this, she must have a proper understanding of free trade, as Robert Peel acquired when he sided with Richard Cobden and abolished the Corn Laws in the 1840s. Unfortunately, Mrs May has little option but to listen to risk-averse advisors and central planners who deny the primacy of free markets, not just for handling day-to-day issues, but also, it appears, to guide her for the broader picture. In short, she has to have an independence and resolve to act despite her advisors’ advice.

Some members of Mrs May’s Cabinet do understand free trade. They include heavyweights such as Boris Johnson, Michael Gove, David Davis and Liam Fox. Even though Philip Hammond, the Chancellor, has been persuaded against it by his permanent staff, the ERG does have powerful allies in the Cabinet.

The ERG understands, to a reasonable degree at least, the fallacies of central planning and the faults of the socialism of the European project, while understanding the benefits of free trade. Its leadership should be well placed for the task. This is where the position of Mr Rees-Mogg is important. He personally appears to understand the benefits of free markets, has a good grasp of the individual Brexit issues, and argues his case well. This is in sharp contrast with the Remain camp, and the middle ground of lobby-fodder on both sides of the House.

That middle ground is his to win, but time is severely limited. To do so he must not only argue his case well, but also get the following points across, loud and clear:

The best outcome for the British consumer is no tariffs, and their removal is the responsibility of the UK Government. The best outcome for the economy is not found in protecting business through trade tariffs, because that is to the detriment of the consumer.

Current EU trade tariffs disadvantage the poor most. This point will become increasingly relevant when price inflation gathers pace ahead of the final Brexit date (March 2019), as the global credit cycle progresses. An appreciation of this simple fact makes tariffs indefensible, and a clean break Brexit becomes more obviously the best solution.

No separation payments should be made to the EU, unless they are specifically itemised and contractually justified. The capital payments demanded by the EU in any political compromise are not only a needless expense, but an imposition on the Treasury’s finances which are already in deficit. Furthermore, the loss of revenue from the removal of all tariffs is a considerably smaller sum than the amounts demanded by the EU negotiators.

The Treasury must be persuaded that free trade leads to a stronger economy, which will be reflected in higher tax revenues. Moreover, a botched compromise, effectively being advocated by the Treasury, is a significant threat to the government’s finances.

There is no need for an implementation or transition period. These extensions do not encourage businesses to adapt to Brexit so much as they delay the necessary changes. Any such period should be firmly restricted to be as short as possible and involve no payment.

In any event, time is short, not only given the Brexit timetable, but ideally it must be concluded, or at least set in stone, before the disruption of the next crisis of the global credit cycle.